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Canadian National Railway Co., with its growth prospects and superior operating performance, is CIBC’s top rail pick. (ANDY CLARK/REUTERS)
Canadian National Railway Co., with its growth prospects and superior operating performance, is CIBC’s top rail pick. (ANDY CLARK/REUTERS)

EQUITIES

The best stocks to tap into U.S. growth Add to ...

For Canadian investors who prefer the comforts of home, there’s hope yet.

Although a grand era of Canadian stock outperformance has ended, there are plenty of opportunities to play what appears to be a strengthening U.S. recovery through Canada.

A number of transportation stocks in particular could be “positioned to take advantage of improving fundamentals south of the border,” Jacob Bout, an analyst at CIBC World Markets, said in a recent report.

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Canadian National Railway Co., with its growth prospects and superior operating performance, is CIBC’s top rail pick, although it is trading above Mr. Bout’s $110 share price target. Air Canada’s continuing turnaround has it leading the airline stocks with an $8 target, while TransForce Inc., with a target of $25, has the best earnings outlook among trucking companies, CIBC said.

Stocks like these are one way for investors who prefer to invest in Canada to participate in a U.S. economy that offers rosier prospects than its Canadian counterpart.

Ideally, Canadian investors would hold U.S. stocks as well, but figures show that investors in this country suffer from an overreliance on domestic equities.

It didn’t matter as much when the S&P/TSX Composite Index consistently beat the S&P 500, as it did for a decade or so.

But the U.S. stock market has now outperformed the Canadian market for going on three years, this year by a gaping margin.

Still, breaking the home bias can prove challenging.

While the typical high-net worth investor in Canada has a 27-per-cent allocation in U.S. equities, the average investor’s exposure is less than half that, according to RBC Wealth Management.

That’s not ideal considering the shifting balance of economic fortunes now appears to favour Canada’s neighbour.

Even David Rosenberg, chief economist at Gluskin Sheff + Associates Inc., who was known until recently as a perma-bear, has taken a buoyant turn regarding prospects for the U.S. economy.

“I’m not taking happy pills, but I am actually feeling better about the future,” Mr. Rosenberg said at a Speakers Forum lecture in Toronto last week.

Lacklustre U.S. GDP growth, which this year is expected to fall short of 2 per cent, doesn’t tell the whole story, he said. Hidden in the statistical mediocrity is underlying economic strength that is overcoming the depressive effect of U.S. tax hikes and spending cuts, which were implemented this year.

“This is the third-most intense period of fiscal drainage out of the U.S. in the post-World War Two period,” Mr. Rosenberg said. “So it’s probably a miracle the U.S. did not fall into a recession.”

With that fiscal bite easing into next year, GDP growth of up to 4 per cent is achievable in 2014, he said.

Meanwhile, for a couple of reasons, Canada is lagging behind in what’s being hailed as the arrival of “economic normalization,” in the United States, Eric Lascelles, chief economist of RBC Global Asset Management, said at the same Speakers Forum event.

“The good reason is that Canada already did participate in normalization,” he said. Canada had a good post-recession run relative to its G8 peers, but now has to contend with a number of domestic drags: a current account deficit, household indebtedness, a beaten-down resource sector and potential downside in the housing market, Mr. Lascelles said.

The best bets on the Canadian stock market, then, could be those that tap into U.S. strength. Industrials stocks, for instance, tend to closely reflect economic growth. “Unsurprisingly, U.S. GDP growth and the S&P industrials index have moved in tandem,” Mr. Bout noted.

Canadian industrials are also doing well. The sector is up 32.9 per cent year to date, much better than the broader S&P/TSX Composite, which has gained 7.5 per cent.

 
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